Today's announcement by the UK Pensions Regulator brings some disappointment, but also some breathing space for trustees and sponsors says Jonathan Smith, UK Strategic Solutions, Schroders
The Pensions Regulator (tPR) has released guidance on how trustees and sponsors of UK Defined Benefit Pension Schemes should approach funding in the current difficult economic climate. Those hoping for leeway on the discount rate, given current low bond yields, will be disappointed. However,we see some potential breathing space for those schemes with sound integrated funding and investment plans.
No leeway on the discount rate
Long-dated gilt yields are at historic lows, which has driven up liabilities substantially (as much as 20% for some schemes in 2011). Many had hoped for leeway from tPR on Technical Provision discount rates, with schemes potentially being able to smooth away some of the impact of lower yields. However, the tPR has ruled this out.
tPR has pointed out that current yields are a combination of a number of economic factors. Some of these might be considered ‘short term' such as QE and the status of the UK as a safe-haven relative to our European neighbours. However, broader issues such as supply and demand have existed for a number of years and are likely to persist for some time. Also, it is not clear how ‘short term' the short term factors will be. As my colleague, Azad Zangana, pointed out on Wednesday, it would be remarkable if the Bank of England did not respond to the current double-dip with a further round of Quantitative Easing.
These considerations point to lower yields for longer, which makes (in tPR's view) smoothing of the discount rate, or assuming higher more ‘normal' yields, hard to justify.
Some breathing space for schemes
tPR has signalled its willingness to accept longer recovery plans for schemes whose sponsor covenant has weakened as a result of the economic climate. This will be welcomed by those who feared that additional contributions could be the ‘final straw' for struggling employers.
tPR has also suggested that trustees might make allowance for improving economic conditions in the recovery plan, provided appropriate contingency plans are in place should improvements not materialise.
However, this increased flexibility is not a free lunch. tPR has stated categorically that, where schemes have bought themselves some more time, it will ‘consider the extent to which trustees have brought the funding, investment and covenant strands together to produce a complete financial management plan'.
Implications for investment strategy
Schemes need to prepare themselves if yields continue to fall, as it now looks unlikely that that tPR will provide a lifeline. For many trustees, this will push funding level risk management further up the agenda.
Furthermore, more so than ever, it is clear that schemes need to think holistically about how they fund their scheme and invest their assets. In its guidance tPR emphasises that any risk in the pension scheme must be supported by the sponsor's covenant (i.e. its ability to plug deficits if risks do not pay off). For schemes with weaker covenants this means thinking carefully about the types of risks they are taking, be they rewarded or unrewarded, and potentially using a wider range of tools to mange risk and generate return.
Finally, trustees need to be able to demonstrate that they have a plan - a plan if things continue to deteriorate, but also a plan to capture funding level gains if these do materialise.
|
